WeS It b

POLICY RESEARCH WORKING PAPER 1868

Government Support For citizens to reap the fu

benefits of private investment
to Private Infrastructure in infrastructure, inFrastructure
pricesmustbe high cncuqgh
Projects in Emerging to cover costs,and private

M arkets investorsmustassurre
commercial risk.Good
macroeconomic policv
Mansoor Dailami matters because it,affectsthe
Michael Klein credibilityof a price reg,me
and especiallythe trust in
currency convertirwiity
essentialfor foreign investors.

The World Bank

Economic Development Institute
RegulatoryReform and PrivateEnterpriseDivision
and
PrivateParticipationin InfrastructureGroup
January 1998
| POLICYRESEARCHWORKINGPAPER1868

Summary findings
Driven by fiscal austerity and disenchantment with the
performance of state-provided infrastructure services,
many governments have turned to the private sector to
build, operate, finance, or own infrastructure in power,
gas, water, transport, and telecommunications sectors.
Private capital flows to developing countries are
increasing rapidly; 15 percent of infrastructure
investment is now funded by private capital in emerging
markets.
But relative to needs, such private investment is
progressing slowly. Governments are reluctant to raise
consumer prices to cost-covering levels, while investors,
mindful of experience, fear that governments may renege
on promises to maintain adequate prices over the long
haul.
So investors ask for government support in the form of
grants, preferential tax treatment, debt or equity
contributions, or guarantees. These subsidies differ in
how they allocate risk between private investors and
government. Efficiency gains are greatest when private
parties assume the risks that they can manage better than
the public sector.
When governments establish good policies -
especially cost-covering prices and credible commitments
to stick to them - investors are willing to invest without
special government support.
Privatizing assets without government guarantees or
other financial support is possible, even where govern-
ments are politically unable to raise prices, because
investors can achieve the returns they demand by
discounting the value of the assets they are purchasing.
But this is not possible for new investments (greenfield
projects).
If prices have been set too low and the government is
not willing to raise them, it must give the investor
financial support, such as guarantees and other forms of
subsidy, to facilitate worthwhile projects that would not
otherwise proceed.
But guarantees shift costs from consumers to
taxpayers, who subsidize users of infrastructure services.
Much of that subsidy is hidden, since the government
does not record the guarantee in its fiscal accounts. And
taxpayers provide unremunerated credit insurance, as the
government borrows based on its ability to tax citizens if
the project fails, not on the strength of the project itself.

This paper - a joint product of the Regularoty Reform and Private Enterprise Division, Economic Development Institute,
and the Private Participation in Infrastructure Group -was presented at the conference "Managing Government Exposure
to Private Infrastructure Projects: Averting a New-Style Debt Crisis," held in Cartagena, Colombia, May 29-30, 1997.
Copies of this paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact
Mansoor Dailami, room G2-071, telephone 202-473-2130, fax 202-34-8350, Internet address mdailami@e?worldbank.org.
January 1998. (29 pages)

i The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about
development issues.An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The
papers carry the namnesof the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this
paper are entirely those of the authors. They do not necessarily represent the view of the World Bank, its Executive Directors, or the
countries they represent.

Produced by the Policy Research Dissemination Center

 GOVERNMENT SUPPORT TO

PRIVATE INFRASTRUCTURE PROJECTS

IN EMERGING MARKETS

MansoorDailamiand MichaelKlein

The authors are Principal Financial Economist at the Economic Development Institute of the World Bank,
and Chief Economist, Shell International (London), respectively.

This paper was presented at the Conference "Managing Government Exposure to Private Infrastructure
Projects: Averting a new-style debt crisis" Cartagena, Colombia, 29-30 May 1997. We would like to
thank conference participants for comments and suggestions. We owe special thanks to Guillermo Perry,
whose vision led us to the conference design and preparation of the paper; Timothy Irwin for editorial
suggestions; Danny Leipziger and Mateen Thobani for insightful comments. We would also like to thank
Anita Hellstern, Albert Amos, and Matthew Harvey for data compilation and building a unique
infrastructure project database.
I
THE GROWTH OF PRIVATE INVESTMENT IN INFRASTRUCTURE

Following the debt crisis of the early 1980s developing countries significantly restricted public
borrowing. The combined public sector borrowing requirement of all developing economies
shrank from 6 percent of GDP in 1982 to 1 percent in 1993 (figure 1).

Figure 1 Public sector borrowing requirement

(percent of GDP)

Percent
0

-2 ---- -- -- - --- -- -- -- -- - --- -- -- ----

- -- - -- - - - - ------ -- ----
- -- - -- - ----- / --- -- -- -- ------ -

-3 \/

-6

. 7 . l I I

1980 1982 1984 1986 1988 1990 1992

Source: World Bank1994.

While public funding has been reduced, infrastructure investment requirements remain high. In
1994 the World Bank estimated them at $200 billion a year for developing countries. Since then
other World Bank studies have increased these estimates. In East Asia and Latin America alone
average annual investment requirements through 2005 have been estimated at $150 and $60
billion, respectively. Investment requirements tend to be dominated by the transport sector,
followed by energy, telecommunications, and water. Required investments often reflect excess
demand for services. That is, consumers would be willing to pay more for services, but prices
are set at levels that are too low to attract suppliers. (Telecommunications may be an exception,
as consumer prices exceed cost-covering levels in several countries, albeit sometimes because
excise taxes are high.)

Driven by fiscal constraints and growing disenchantment with the performance of state-provided
infrastructure services, more and more governments have turned to private solutions for
financing and providing telecommunications, energy, transport, and water services (World Bank
1994). The trendsetters were Chile, the United Kingdom, and New Zealand. Deregulation of
many sectors-including telecommunications, airlines, independent power generation, natural
gas production and transmission, and freight traffilcby road and rail-began even earlier in the

1
United States in the late 1970s. During the 1990s the dual trend toward private involvement in
infrastructure and deregulation has caught on in almost all countries.

Private markets are responding with vigor.' From 1990 to 1996 total net resource flows to
developing countries rose from $101 to $285 billion a year (table 1). Private flows rose from $44
billion to $244 billion, while official development finance dropped from $56 to $41 billion.
Cross-border flows dominate infrastructure finance, even in countries with very high national
saving rates, partly because of the benefits investors gain from diversification but partly because
of the underdevelopment of local capital markets in these countries.

Table 1 Net long-term resource flows to developing countries

Year 1990 1996

In billions In billions As Shareof Total
of dollars As Shareof Total of dollars
Total flows 100.6 100 284.6 100
Sources
Official development finance 56.3 56 40.8 14
Private flows 44.4 44 243.8 86
Recipients
Public sector 62.8 62 84.8 30
Private sector 37.8 38 199.7 70
Foreign direct investment (24.5) (24) (109.5) (38)
Portfolio equity flows (3.2) (3) (45.7) (16)
Nonguaranteed debt (10.1) (10) (44.5) (16)
Bond (0.1) (0.1) (20.8) (7)
Source:WorldBank 1997a.

Increasingly, private capital has funded private projects and firms rather than public
expenditures. Between 1990 and 1996 public sector borrowing from private sources rose from
$63 billion to only $85 billion, barely offsetting the drop in official development finance. In
contrast, private capital (debt and equity) to private recipients rose from $38 billion to $200
billion.

Total infrastructure financing raised by developing countries rose from less than $1 billion in
1988 to more than $27 billion in 1996. Finance for private infrastructure rose from virtually
nothing in 1988 to more than $20 billion in 1996 (table 2). Although the data on infrastructure
capital flows are not strictly comparable with the data on capital flows, cross-border private
infrastructure finance appears to account for about 10 percent of all private-to-private cross-
border capital flows. About half of cross-border flows are invested from local sources in private
infrastructure projects, so that total private investment may currently account for about 15
percent of a total estimated investment requirement of $200 billion a year.

2
 Table 2 Private cross-border financial flows to infrastructure
(billions of U.S. dollars)

1988 1989 1990 1991 1992 1993 1994 1995 1996

Total 0.1 0.9 2.0 3.5 5.8 12.3 15.7 15.6 20.3
Loans 0.1 0.8 1.4 0.1 1.5 6.3 6.0 11.1 7.7
Bonds 0 0.2 0.5 0.7 1.1 3.9 5.8 3.3 7.2
Equity 0 0 0.1 2.6 3.1 2.1 3.9 1.3 5.4
Latin America
and Caribbean 0 0.2 0.3 3.1 3.6 4.7 6.6 2.1 7.8
Loans 0 0 0 0.02 0.2 0.3 1.6 0.7 0.7
Bonds 0 0.2 0.3 0.6 1.0 3.3 3.7 1.4 4.4
Equity 0 0 0.1 2.5 2.4 1.1 1.3 0 2.8
East Asia and
Pacific 0.1 0.8 1.5 0.4 2.0 5.7 6.8 8.8 9.3
Loans 0.1 0.8 1.3 0.05 1.2 4.6 3.4 6.1 4.9
Bonds 0 0 0.3 0.2 0.2 0.3 2.1 1.7 2.4
Equity 0 0 0.02 0.1 0.6 0.8 1.3 1.0 2.0
Source: WorldBank 1997a

Almost half of all private cross-border infrastructure finance appears to have been invested in
East Asia, and more than a third was invested in Latin America (table 2 and figure 2). Power
projects have attracted the highest share of investment, accounting for more than 40 percent of
the total, followed by telecommunications and transport (figure 3).

Figure 2 Cumulative private sector borrowing for infrastructure, 1986-95

so

40

30 .

20 _
30.

10

Sub-SaharanAfrca SouthAsia LatinAmerica and the Caribbean

3
 Figure 3 Sectoral composition of infrastructure financing in developing countries

198690 1991-95
Telecomriunications
4% Other infrastructure

\33°/ l

Source: EuromoneyLoanware and Bondware and World Bank Staffestirrates.

Between 1990 and 1994 private infrastructure finance to developing countries grew at an annual
average rate of 67 percent, reflecting the low base from which it started. Since 1994 growth has
averaged 14 percent a year, well below the 19 percent growth rate of total private capital flows to
developing countries (figure 4). (See also annex tables Al-A4).

Figure 4 New private flows to infrastructure, 1990-96

200
180
160
140
120
100
80.
60
40
20
0
>n N C9 e In (Dl

_ TotaInet flots oprivate projects

- Totainet flovs toprivae infrastructure

Source:WorldBank 1997a

4
WHY INFRASTRUCTURE
Is DIFFERENT

To understand why private financing of infrastructure has not kept pace with overall financial
flows to private entities it is necessary to recognize how infrastructure differs from other
industries.

First, infrastructure services are often considered essential by consumers, and they are frequently
provided by monopolists. Together these factors increase political sensitivity to the prices
charged. Pressure from consumers to keep prices low makes it politically difficult for
governments to maintain prices that cover costs. Indeed, the World Bank (1994) estimated that
user fees fell far short of costs in gas, electricity, and water.

Second, infrastructure projects typically require large sunk investments that take ten to thirty
years to recoup. Over such long periods of time investors are exposed to serious risks, in
particular the risk that public authorities will not honor their agreements on tariff policy and
payments to investors (Klein and Roger 1994). Once investors are committed to projects-and
can pull out only by taking a huge loss-governments may be tempted to lower prices or not
raise them as agreed. Investors thus risk being the victims of what has been called the
"obsolescent bargain."

These factors help explain the familiar privatization-nationalization cycle that has been observed
repeatedly (figure 5). Private entrepreneurs may initially develop infrastructure-building the
first electricity networks, for example.2 As these networks expand toward territories operated by
other entrepreneurs, companies merge with or acquire their neighbors, creating larger,
consolidated firms. These new firms are perceived as possessing significant monopoly power,
and the services they provide-once considered luxuries-are now considered essential, creating
pressure for monopoly regulation. Regulation, in turn, reduces prices and profitability, which
discourages maintenance and new investment. In the face of declining quality and a slowdown
in the industry's growth, the government nationalizes the firn. Low prices and inefficiency sap
the finances of the state-owned firn, obliging the government to subsidize it. The very
availability of subsidies, however, encourages more inefficiency. Eventually, concerns about
fiscal subsidies and inefficiency create pressure for prices increases and privatization-and the
cycle begins again.

5
 Figure 5 The privatization-nationalization cycle

7 aeova
veron o /a2pa

fenreases
cuts\ /3
d srice

\1 Regulabon ofeeand
ser s franchises

e s c nicienc
investors are tpclyuDecline in

cannotfullyproectinestrsgansttheeffrtofadtemindebility orofitability

possibya of cuc W l bthdwawal/

adj t b e of ptakeover if acrpital a s

Source:Gomez-sbanezand Meyer ( 993).o

Becauseof the problem of sunk costs, and the historicalexperienceof the "obsolescentbargain,"
investors are typically unwilling to make investments without adequate, frequently complex,
contractual protection (Dasgupta and Sengupta 1993; Edlin and Reichelstein 1996). The
negotiationof such contractsis time consumingand costly, however,and even the best contracts
cannot
p ully protect investheorm synicatedts of a deter ined goverknsent. Enforceabilityof
thesecontractsis essential,but it is difficultto achieve. Investorsare condinuallyfaced with the
possibilityof changingcontractualagreementsor failure by the govecnmentto implementtariff
adjustmentsbecauseof politicalconsiderations. Even if arbitrationand settlementof disputesin
a third countryare agreedoin radvance-such as in the case of the Enron-Dahbolpower project
in India-such procedurescap contimitonsuming and can add to the cost of the project.

The heavy foreign financing of infrastructure creates additional risks. Most infrastructure
projects in developingcountries are financed with significantamnountsof foreign capital. A
typical financingmix consists of 20-40 percent equity (providedby projectpromoters)and 60-
80 percent debt, in the form of syndicated commercialbank loans, bond issues, bridge and
backup facilities,and multilateraland export credit agency loans and guarantees. Exposure to
currency risk, which is a relatively minor concern for foreign investors in export-oriented
manufacturingindustries, is a critical feature of infrastructureproject investment. Project
revenues are often generated in local currencies,while servicing of foreign debt and equity
involves payrnent in foreign currency. Fluctuations in the exchange rate of the domestic
currency,as well as capital controls limiting currency convertibilityand transferability,create
risk for foreigninvestorsand financiers.

6
While prospects for currency convertibility and transferability have improved in many
developing countries with the liberalization of their capital accounts and the surge in foreign
capital inflows, the scope for exchange rate hedging and risk management through the use of
forward markets or derivatives remains limited. With the exception of Malaysia, Thailand,
Brazil, and Mexico, where currency swap and forward markets have grown in the past two years,
foreign exchange markets in developing countries suffer from a lack of instruments and liquidity.

The case of the Argentine private natural gas transport company, COGASCO, illustrates several
of these problems. COGASCO started operating in 1981, with a guarantee from the central bank
that it would be able to convert into hard currency its peso revenues from gas deliveries to state-
owned Gas del Estado. In 1982 Argentina's foreign exchange reserves were low because of the
conflict with the United Kingdom, and the government would have had trouble honoring its
convertibility guarantee. Gas del Estado then reviewed the contract with COGASCO and
claimed breach of contract, complaining that COGASCO had found a more efficient way to run a
liquid petroleum gas extraction plant than foreseen in the contract. The dispute meant that
COGASCO was not paid, mooting the issue of currency convertibility. Because the investor's
costs were sunk it had little leverage with the government and the government was unable to
renege on its comrnmitment.The dispute lasted until the late 1980s, when COGASCO and its
parent company went bankrupt and foreign investmnentin the gas sector ground to a halt.

Because of this kind of risk, investors require high ex ante rates of return. In many cases real
rates of return on equity exceed 20 percent (see annex table AS). This often results in prices that
are higher than they were before privatization, when the real cost of capital was not taken into
account.

PROVIDING FINANCIAL SUPPORT TO ATTRACT PRIVATE INVESTORS

To render projects attractive to investors despite these risks, governments have to raise user fees
or provide special financial support to projects. Whichever route they choose, they need to
provide credible assurances to investors that sensible binding obligations (the "rules of the
game") will be honored.

Governments use an array of mechanisms to provide financial support to private infrastructure

projects (table 3).3 Some of these mechanisms, including preferential tax treatment, grants, and
equity or subordinated debt contributions for which governments do not expect commercial
returns, directly enhance project cash flow. In contrast, guarantees are targeted at particular
risks, such as the risk that a state-owned party will renege on an obligation.

7
 Table 3 Types of sovereignor supranationalsupportfor privateinfrastructureprojects
Multilateral Government Informal Multilateral Government Government Multilateral Government Preferential
Banks and Guarantees Agreementsa Banks and Equity Debt (Senior Equity Grants Tax
Export Credit Export Participation and Sub- Participation Treatment
Agency Debt Credit ordinated)
Agency
Guarantees
Country Honduras: India Mexico:Mexico Peru: Malaysia Pakistan: Philippines: Brazil Linha Chile:450-
and Electricidadde Dabbol 695- CityToluca Toll Aguaytia Kuala Lumpur Rousch412- Pagbilao 735- Amerala MW Empresa
Project Cortes S. De MW power Road 145-MW Sepang Airport MW power MW power (10-yr., 15 Electica
R.L de C.V plant; gas-fired plant CCPP plant, coal fired, kIn, 6-lane Pangue
(Elcosa1 60- combined power plant residual fuel 25-year PPA road)
MWoil fired cycle; oil; 30-year with National
powerplant; imported PPA with Power Corp.
15-yrs.PPA liquefied Water and
natural gas Power
(LPGYoiI Development
distillate;20 Authority
year PPA
vwith
Maharashtra
State
Electricity
Board;
tariff 2.4
($S126)per
rupees KWh
Project cost $70 million $922 million $313 million $235 million $3,924million $507 million $933 million $174million $465 million
Date 1994 1995 February 1992 October 1996 1993 1996 1993 June 1996 1993
financial
closure

Example by IFC:$10.5 m 12-year Concession OPIC: $60 $390 m in $40 m standby IFC: $60 m $112 million $10 millionin
mechanism senior debt counter- guarantees m political equity loan by ADB: S40m grant from the deferredtax
(LIBOR + 375 guarantee traffic volumes risk providedby National CDC: $35 m Rio de Janeiro duties
bps, 12-yr. from the by vehicle guarantee the Development municipal
maturity) goverunent category,if governmentof FinanceCorp. government
of India for trafficvolumes Malaysia (NDFC)
FMO: (Dutch) tariff- fell shortof $140 m sub-
$10 m senior paymentsby amounts ordinateddebt
debt (LIBOR+ the specifiedin channeledto
375 bps, 12-yr. Maharashtra contract, the Pakistan
maturity) State Concessionaire Fund from the
Electricity entitledto WorldBank
IFC B: SlOm Board;and request an ($70m) and
loan, 8-yr. termination extensionof the JEXIM
maturity guarantee concessionterm ($70m)
(cappedat to permit
IFC: $3.5m $300m) recoveryof its
subordinated investments.
debt

FMO: (Dutch)
$1.0m
subordinated
debt
a. Informal agreements include comfort letters, side agreements,nonbinding tariff increases, and other
similar agreements.

The govermment's obligations to provide support can be defined in laws, decrees, statutes,
licenses, concessions, contracts or other legally binding documents. Most countries have also
signed some of the more than 1,200 bilateral investment treaties that define investor rights.

Investors and their counterparties normally agree on suitable methods for dispute resolution. If
local courts are not credible, the parties can agree to international arbitration. Most countries

8
have agreedto internationalconventions,which establishappropriatearbitrationmechanismsand
renderarbitral awardsenforceable.

In some cases counterpartiesmay lack the cash flow with whichto pay investors. Investorsthus
often seek additional assurances that any compensationdue them under the terms of their
contract will actuallybe paid. For example, the central governmentsmay be asked to provide
assurances that a publicly owned electric utility will honor its contracts with the private
generatingplants from which it buys power. Investorsmay also seek guaranteesthat their local
currencyearningswill be convertibleand transferableout of the country.

In sum, infrastructureinvestorsrequire special assurancesthat money due to them will be paid

when due, in the currencythey require. In this sense, all forms of governmentsupportultimately
amountto cash flow supportto a project and have a significantfiscal impact.

Support through Government Guarantees

Governments often provide financial support by means of guarantees (box 2.1 and table 2.4).
Central governments often guarantee the performance of subsovereign entities, including public
enterprises and provincial or municipal governments.4

Box 1 Government guarantees in OECDcountries

Governmentsthroughoutthe world provide guarantees to private investors in a variety of activities

Prominent among such guarantees are deposit insurance for bank depositors and pension or social
security insurance. Guarantees for housing, agriculture, students, exports, and public corporations
dominate the picture in OECD countries; little is known about the make-up of guaranteeexposure in
developingcountries. Even in OECD countries informationon guarantee exposure is sketchy. Data
suggestthat total guaranteeexposuremay amount to 15-20 percent of GDP, or more than a quarter of
gross debt. This does not, of course, capture implicit guarantees, under which govermnentmay feel
obliged to bail out failing firms or banks or help uninsured citizens in need (in the wake of natural
disasters,for example).

Guaranteeprogramscan providevaluablesupportfor private economicactivity. But they can be costly:

in recent years several industrial countries have suffered large losses under some of their guarantee
programs,includingdepositinsuranceand exportcredits. Duringthe 1980sOECDexportcredit agencies
incurred losses equivalentto about 20 percent of new business,while collecting premiums of only 3
percent. Mostof the exportcreditlosseswere on medium-and longer-termcredit. Thisexperience
prompteda change in guaranteemanagementprocedures.The United States has institutedmore
transparentaccountingprinciples for its guaranteeoperationsunder the 1991 Credit Refonn Act. The
experienceof exportguaranteeschemesis relevantfor governmentsconsideringguaranteeinglong-term
infiastructureinvestment,as risks are similar (medium- to long-termcountryrisk), althoughthe risk in
infrastructure investment may be higher because of the risk of regulatory failure or creeping
expropriationfor firms with immobileinvestments,such as powerplants.

9
 Table 4 Types of government guarantees in private infrastructure projects
Type of guarantee
Contractual obligations of government entities
* Guarantee of off-take in power projects
* Guarantee of fuel supply in power projects
Policy/political risk
* Guarantee of currency convertibility and
transferability
* Guarantee in case of changes of law or regulatory
regime
Financial market disruption/fluctuations
* Guarantee of interest rate
* Guarantee of exchange rate
• Debt guarantee
Market risk
* Guarantee of tariff rate/sales risk guarantee
* Revenue guarantee
Projects
Birecik Hydro Power Plant, Turkey
Electricidad de Cores, Hungary Paguthan &
Dabhol Power Plants, India Mt. Aop
Geothermal Plant, Philippines
Termopaipa Power Plant, Colombia Lal Pir
Power, Pakistan
Lal Pir Power, Pakistan
Rousch Power, Pakistan
Izmit Su Water Treatment Plant and
Pipeline, Turkey
North-South Expressway, Malaysia
North-South Expressway, Malaysia
Toll roads, Mexico
Termopaipa Power Plant, Colombia
Don Muang Tollway, Thailand
Western Harbour Tunnel, Hong Kong
Buga-Tulua Highway, Colombia
Toll roads, Mexico
South access to Concepci6n, Chile
M5 Motorway, Hungary
10
Through central government guarantees, project risks, such as the ability of a public utility to pay
its private suppliers, can be transformed into countries risk. Countries can reduce their exposure
by replacing full credit guarantees with more narrowly defined guarantees such as power
purchase agreements. Such unbundling of risks presumes that the parties can be trusted to honor
their commitments; if they cannot be trusted, investors will prefer full guarantees. This helps
explain why countries with low credit ratings rely heavily on full financing by export credit
agencies or multilaterals, whereas countries with higher credit ratings offer guarantees for
specific risks (see table 2.5). Support by multilaterals and export credit agencies appears to
substitute for an international contract enforcement mechanism.

Table S Patterns of sovereign or supranational support for private infrastructure projects

Number
Multilateral Banks and Export Credit Agency
Debt
Government Guarantees
Informal Agreements'
Multilateral Banks and Export Credit Agency
Guarantees
Govemment Equity Participation
Govemment Debt (Senior and Sub-ordinated)
Multilateral Equity Participation
Govemment Grants
Preferential Tax Treatment
Pattern
37 Greaterincidenceof debtassistanceby multilateral
banks and ECAsin non-investmentgradeemerging
markets(27).
28 Nearlythreetimes as manygoverment guarantees
in non-investment-gradecountries (24) than in
investment-gradecountries(9).
28 Although9 agreementswere issuedin Mexico,use
of infonnal agreements is more common in
investmentgradecountries(11).
26 Slightlymore examples among non- investment-
grade emergingmarkets (15) than in investment-
gradecountries(11).
18 Greaterincidenceof governmentequityparticipation
in investment-grade
countries(I1).
14 Equal splitamongnoninvestment-and investment-
gradecountries.
13 Much greaterincidenceof equity share-holdingby
multilateralbarnksarid ECAs in non-investment-
gradeemergingmarkets(I1).
12 Greater incidence of govemnmentparticipation
throughgrants in non- investnent grade countries
(8).
2 Limited use of preferential tax treatment in
investmentgradecountries.

Note: Financingpackagesof 78 projects (39 power, 26 transport,7 water/waste,4 telecommunications,

and 2 gas) were disaggregatedand then tabulatedby type of mechanismand source of funds. All 78
projectshas direct participationby the private sectorthroughthe provisionof debt, equity,or both.
a: Informalagreementsinclude comfort letters, side agreements,nonbindingtariff increases,and other
similaragreements.

Valuing and Charging for Government Guarantees

Guarantees provide (contingent) cash flow support to projects and are, in many respects, similar
to loans or grants. To be able to compare all forms of assistance, it is useful to calculate the
subsidy implicit in each form of support. These "subsidy equivalents" help determine, for
example, whether it is cheaper for the government to provide a guarantee or some other form of
support. (For more on the role of guarantees in infrastructure finance see Dailami 1997.)

11
The fact that government guarantees can be valued and may be expensive to government does
not imply that governments should charge investors for the guarantees. When government
guarantees merely substitute for low prices, charging the full cost of the guarantee would defeat
the purpose of the guarantee.

When the guarantor can manage or bear the risk better than the investor, however, the value to
the guaranteed party is higher than the cost to guarantor, and the investor may be willing to pay
part or all of the cost for a guarantee. Some commercial risks are insured by private insurance
companies for this reason. Governments, however, should not be insuring commercial-risks,
even on a fee basis.

To the extent that private insurers are willing to provide cover for political risk, they need to
charge for the value of a guarantee. Governments, however, would be extracting rents from good
policy by charging for such guarantees: charging for political risk guarantees would be akin to
demanding protection money. Governments should instead ensure that the benefits to investors
of such guarantees are passed on to consumers-by awarding projects competitively, for
example.

Complications Arising from the Risk of Sovereign Default

Sometimes the government's power of taxation enables it to honor any obligations it has entered
into to provide support to a private infrastructure project. Official export credit and mortgage
insurance schemes in the United States are examples. In some developing countries, however,
the risk of sovereign default is real, and its implications must be considered in structuring
government support to private infrastructure companies. The key task is to evaluate
infrastructure projects financially within the country risk environment prevailing in developing
countries (see Dailami and Leipziger 1997).

When there is a risk of default, one or more creditors or investors may lose all or part of their
investment. By obtaining government guarantees an investor or creditor obtains a position near
the front of the queue for repayment and secures access to sources of compensation not related to
the project, generally taxation. By obtaining a supporting guarantee from an institution such as
the World Bank, a private investor can buy a place right at the front of the queue, benefiting from
the preferred creditor status of the World Bank. It is not clear, however, whether such guarantees
simply improve some investors' positions relative to others' or whether it contributes to a better
overall outcome (see Dooley 1997).

The key issue is whether and how the structure of government liabilities may affect the outcome
of government liability renegotiations. Even if renegotiation of government liabilities over
extended periods of time preserves the net present value of creditor or investor claims, there may
be real economic losses, since assets funded by investors may not be used as efficiently as they
would otherwise have been during the often acrimonious work-out process. For example, a
water concession may not be maintained as well during a dispute as otherwise.

12
Different creditors or investors hold different types of claims. They thus have varying interests
to negotiate. Some "tough" investors may hold up renegotiation, thus imposing real losses (due
to the less efficient use of assets during the renegotiation), for which the tough investor does not
pay. When a government issues guarantees to an infrastructure investor it tends to create yet
another type of claim. In particular, the guarantee may be issued to an investor who has some
physical control over the assets. This gives the guarantee holder bargaining power that differs
from that of a holder of sovereign debt, for example. To some extent that may be justified for the
same reason that trade credit gets treated preferentially during debt renegotiations so as not to
disrupt basic economic activity with adverse consequences for all.

To achieve a solid and reasonably speedy settlement in order to minimize economic disruption
resulting from inefficient asset use, a mechanism needs to be in place that allows creditors and
investors to resolve their differences quickly. This is achieved more easily if the claims held by
different investors are similar and the government has the flexibility to come up with various
ways of settling its obligations.

When a country properly accounts for its contingent liabilities and reserves for them fiscally,
they appear more like normal debt. In fact, it may be preferable for the government to support
projects by providing debt finance rather than guarantees. If so, it could be argued that, to
provide governments with the right incentives to do so, exposure under government guarantees
should be valued like debt and not be reduced by adjusting for probability of default. In a sense
such an ultra conservative policy is equivalent to debt management policies in various advanced
OECD countries. Germany, for example, actually values certain guarantees the same way as
debt with the same maximum exposure.

Beyond making claims more similar to each other, can a commitment mechanism be chosen to
facilitate speedy claims resolution? The COGASCO example, mentioned earlier, illustrates that
project-based renegotiation can last as long as sovereign debt settlement, with deleterious
consequences for investment in a particular sector. It may therefore be useful to involve
multilateral creditors, because their interests and actions may be most closely aligned and they
may thus help advance resolution most speedily.

It is thus by no means clear that finely tuned risk allocation is always the right approach. Blunter
instruments, such as straight sovereign debt, may at times be preferable. The argument for
seeking participation by multilaterals may have little to do with the nature of the risk
management or product they provide and more with the role they are likely to play in debt
renegotiation.

REFORMING
POLICYTOATTRACTINVESTORS

Although guarantees can provide some comfort to investors, a country's interests are better
served by thorough-going policy reform. The best way of attracting private investment is by
establishing stable macroeconomic policies, adequate tariff regimes, a track record of honoring

13
commitments, and reasonable economic policymaking. In many OECD countries and other
industrial economies, such as Singapore, investors may not require guarantees or other
government support, and they may be willing to accept "change of law" risk, which may affect
tax rates or other project cost or revenue parameters.

In many emerging markets, however-including relatively advanced economies, such as Chile-

investors may not find the right policies in place, or they may doubt the government's ability to
sustain such policies over long periods of time. Governments still have a variety of options for
reducing the need for special project support.

Projects are subject to country- and project-specific risks. Risks related to a country's overall
health tend to be of prime importance. Risks such as currency and interest-rate risks reflect
macroeconomic volatility and the risk that the government will not honor its obligations (country
risk proper).

That governments with stable macroeconomic policies can attract private infrastructure investors
more easily is reflected in the sovereign debt ratings given by various rating agencies and
services (see annex table A5). As country ratings improve, governents are able to attract more
and more project finance (table 6) (although project finance accounts for only a small percentage
of GDP in the most creditworthy countries, where corporate finance is used to finance deals).5

Table 6 Credit ratings, deals per capita, and deals as a percent of GDP, by country, 1996
Country Rating Deals per capita Country Rating Deals as a percentage
($/population) of GDP
Qatar BBB 8,564 HongKong A 13.5
HongKong A 3,229 Indonesia BBB 7.1
Australia AA 705 Thailand A 5.7
Greece BBB- 282 Chile A- 4.9
Chile A- 234 Pakistan B+ 4.5
UnitedKingdom AAA 227 Malaysia A+ 4.2
SaudiArabia NR 214 Australia AA 3.7
UnitedStates AAA 185 Greece BBB- 3.2
Malaysia A+ 178 SaudiArabia NR 3.1
Thailand A 159 Turkey B 2.4
Canada AA+ 151 India BB+ 2.1
Argentina BB 99 Argentina BB 1.2
Italy AA 78 China BBB 1.2
Germany AAA 76 UnitedKingdom AAA 1.2
Indonesia BBB 73 Brazil BB- 0.8
Turkey B 63 Canada AA+ 0.8
Brazil BB- 37 UnitedStates AAA 0.7
Pakistan B+ 21 Italy AA 0.4
India BB+ 7 Germany AAA 0.3
China BBB 7 Qatar BBB NA
Note: Population and GDP data are for 1995.
Source:Euromoney;World Bank 1997b; World Bank staff estimates.

14
Problemswith FinancialSupportwithoutPolicyReform

The jury is still out on the consequences of government guarantees and other forms of financial
support: although they may have increased the volume of investment, they may not have solved
the underlying problems. Several examples illustrate the types of problem that can remain when
projects go ahead, with various forms of governments support, in the absence of serious policy
problems.

The Mexican toll road program generated several billion dollars of non-performing assets in the
domestic banking system. No explicit guarantees had been issued to creditors, but local banks
expected the government to bail them out once the toll roads ran into financial difficulties. The
government was forced to come to the banks' aid at the worst possible time-during the currency
crisis of 1994/95.

The failure of private toll roads has caused problems in other countries as well. In Thailand the
Bangkok expressway required government rescue after the authorities declined to raise tolls in
line with earlier agreements. In Spain the government was obliged to pay out $2.7 billion when
exchange rate guarantees were called during the 1970s and 1980s.

Other types of projects have also been affected. Malaysia's power company, TENAGA,
contracted with private generators (backed by a government guarantee) to supply more power,
but consumer tariffs were left unchanged. As a result TENAGA was not able to carry the full
cost of private generation forward and was squeezed financially, forcing it to negledt
maintenance and investment. Power cuts throughout the country followed-exactly the outcome
the new generation capacity was intended to prevent.

In Mexico a water concession in Aguascalientes was concluded in 1993. To guard against

currency risk, variable-rate debt financing was obtained in the local markets. Water prices were
thus not indexed to exchange rate movements but (partially) to changes in interest rates on
domestic debt and inflation. Following the foreign currency devaluation in 1994/95 inflation and
domestic interest rates rose, which should have caused large nominal tariff increases. A political
decision was made, however, not to raise tariffs as foreseen in the concession contract. Instead
the government took on the financing of new investment that the concessionaire was supposed to
have made.

These cases have some key features in common. First, problems were resolved by negotiation,
as they usually are in cases of government-related risks. In contrast, disputes over technical or
commercial risks are often resolved in court. Second, the government generally ended up
bearing a substantial part of the costs-costs that could have been avoided if the government had
allowed consumer prices to cover full project costs.

These examples reveal how the basic forces that drive infrastructure privatization assert
themselves. Private investors do not-and should not-pay for projects; they can only finance
them. Either consumers or taxpayers have to pay for projects in the end. If the government

15
cannot raise money from taxpayers, consumer prices must be adequate. Therefore, when
privatization is motivated by fiscal constraints, user fees must be raised to cost-covering levels.
Projects that cannot be funded by user fees should not, in the absence of important positive
externalities, be built.

Government support could lower overall project cost only if the government had a lower cost of
capital than private parties. Although government borrowing costs are often ostensibly lower
than private borrowing costs, governments borrow at lower rates not because they tend to operate
lower risk projects but because taxpayers stand behind them, providing unremunerated credit
insurance. If taxpayers were remunerated for their exposure, the ostensible advantage of
government finance would presumably disappear. If not, governments should finance
everything, including large corporations-a return to GOSPLAN, which appears nonsensical
(Klein 1996).

Government support to private projects compensates private investors for the risks they are
unwilling to bear given the prices they receive. Investors may be attracted to infrastructure
projects without guarantees if the expected returns are high enough (that is, when rates charged
to consumers are high enough).6 In that sense the search for guarantees or other forms of
government support is a search for suckers who can be made to pay what others are not willing to
pay. Guarantees themselves do not appear to affect the cost of capital, which is determined by
the risks of the project, not the financing structure. As recent review of the effect of World Bank
partial credit guarantees (Huizinga 1997) suggests, the existence of guarantees did not reduce
nonguaranteed interest rates, and the duration of nonguaranteed debt remained relatively short.

Privatization of Existing Assets

Recent transactions have shown that even countries with subinvestment grade ratings can attract
sizable private investment without special government guarantees if sound sector policies are
made credible. Privatizing existing assets reduces the role of government and with it fears of
noncommercial interference. In Argentina, Peru, and Bolivia, for example, where certain sectors,
such as electricity, were privatized, private investment has been made without government
guarantees.

Privatization also allows investors to earn high rates of return without raising consumer tariffs,
since investors discount the sale value of assets to the point at which existing tariffs generate the
required rate of return, rather than by raising tariffs, as they would have to do in greenfield
projects. In fact, tariffs can actually fall after privatizations, as they did in the Buenos Aires
water concession, in which the assets of the system were given to the private investor free of
charge.7

Privatization has also attracted more equity investors than have new investment projects. Since
equity markets are easier to develop than long-term debt markets in most developing countries,
privatizations have been able to rely more on local currency financing than have greenfield
investment projects. The typical new investment project requires about two-thirds foreign

16
finance, whereas the typical privatization has attracted two-thirds of its finance from local
markets (International Finance Corporation 1996).

Many privatizations have occurred in subinvestment grade countries (that is, in countries with
credit ratings of less than BBB-), including Argentina, Peru and Bolivia. Privatization has
allowed these countries to attract investment despite their unstable macroeconomic
environments, allowing them to make the most of existing assets rather than to add new
investments.

Greenfield Projects

Government guarantees and financial support are more difficult to avoid for new investments, for
which prices must be raised. Well-structured project finance for greenfield projects may allow
governments to avoid guarantees or other forms of support, however. Under project finance
investors look to cash flow generated by the project to amortize debt and to pay interest
payments and dividends.8 Project finance can help investors structure a project so that different
risks can be separated and allocated to the parties most willing to bear them. An example is the
Mamonal power project in Colombia, where a foreign power generator sells electricity directly to
private firms at cost-covering prices. This project structure has allowed the project company to
set high user fees and rely on payment discipline by creditworthy corporate customers rather than
on government guarantees.

Several countries are trying to reduce reliance on sovereign support for new infrastructure
projects. Most of the countries that have been successful in doing so have had investment-grade
ratings. Indonesia attracted investors by issuing comfort letters on foreign exchange
convertibility in its PAITON power project. China and India have declared that they are
unwilling to issue sovereign guarantees for private infrastructure projects. In China, an
investment-grade country, investors have been willing to accept guarantees from provincial
governments in place of the national government. In India, a subinvestment-grade country, the
verdict is still out, but it appears that projects going ahead require heavy backing from state-
owned financial institutions.

Colombia, an investment-grade country, has been able to move away from sovereign guarantees
in projects in which ECOPETROL, the state-owned oil company, is backing payment obligations
(Centragas and Transgas). Several Colombian entities have recently issued investment-grade
paper (for the El Dorado airport expansion and the city of Bogota). Petropower, a Chilean co-
generation project, was able to issue bonds in the U.S. capital markets without the help of the
government or supranational agencies. Although Argentina is not an investment-grade country,
Transportadora de Gas del Norte in Argentina was able to issue investment-grade paper with the
help of IFC participation (other innovative capital market issues are described in annex table
A6).

17
Rethinkingthe Problemof Future InvestmentRequirements

The "financing gap" may in fact be a "policy gap"-what is needed is not so much the
mobilizationof new financial resources on a vast scale but a thorough-goingreform of policy.
Raising consumer prices to cost-coveringlevels would generate some $123 billion a year,
allowing infrastructure companies to fund most of the $200 billion a year needed for
infrastructurefrom internalcash generation,leavingonly $77 billionto be funded in the financial
markets (World Bank 1994). In addition,private participationcould create efficiencygains of
$55 billion a year, reducing financing requirementsto $22 billion (figure 6). Moreover, the
increase in tariffs to consumers should reduce demand and therefore investmentrequirements.
To be politicallyable to raise consumer prices and to obtain the benefits of greater efficiency,
governmentsshould proceed with privatization. If they choose to go this route, however, the
long-runfinancingproblems will be minimal-financing requirementsfrom sources other than
internalcash generationmay not be muchlarger than the existinglevel of private capitalflows.

18
 Figure 6 Estimated cost of mispricing and technical inefficiency

Billionsof U.S. dollars

250

Investment
200

Fiscal
150 burden _
123 c

W X
loo | - l Resource
loss

Subsidiesincurred Costs incurredfrom Annual infrastructure

from mispricing technicalinefficiency investment

* Water * Roads * Developmentfinance

[] Railways * Power E All othersources

inefficiency,overstaffing,and locomotive
a. Costsfor the watersectorare dueto leakages;for wailways--fuel unavailability,
for roads--
addedinvestmentcausedbypoormaintenance;for power--transmission, distribution,and generationlosses
Source:Ingramand Fay,backgroundpaper; AppendixtableA.4.

The shift to private infrastructure finance reduces the financing requirements of the country as a
whole only if private investors generate efficiency gains (that is, they provide the same level of
service at lower cost). For efficiency gains to materialize the private sector needs to bear risks it
can manage better than the public sector. As long as financial structures are found thdt shift
some of those risks away from the government-even if limited guarantees remain-benefits cah
be obtained from privatization. The fact that privatization reduces the likelihood of
noncommercial interference by government can be the source of major efficiency gains (Gahlal
Tandon,and Vogelsang1994).

Managing Guarantee Exposure during the Transition

In the long run, governmentscan attract private investmentin infrastructurewithout providing

guarantees if they have good policies in place. The most difficult challengesarise duritig the
transition from publiclyto privatelyfunded infrastructure,when guaranteesare most common.
Even during the transition, however,governmentguaranteesrisk simply postponingthe day bf
reckoning. Assumingthat private investors cannot consistently be duped into investiingiti
unsustainable projects, providing guarantees imposes costs on taxpayers in the future. For this
reason alone governments should develop ways of quantifying all their exposures to private
infrastructure projects and reserving for them fiscally.

Two governments in the developing world-the Philippines and Colombia-are trying to

develop ways to manage their guarantee exposure. Both countries are establishing ways of
valuing their exposure and creating fiscal reserves against it. Managing guarantees correctly will
demonstrate the fiscal cost of not implementing good policies and help garner support for more
lasting reform.

Governments must also recognize their exposure from implicit guarantees. Ways must be found
to manage implicit guarantees by letting investors (at least equity investors) go under in case of
failure. Mechanisms must be established that allow new investors to take the place of old ones to
ensure service continuity to consumers. If this cannot be done, implicit guarantees should be
treated like explicit ones, and reserves should be budgeted to cover these contingent liabilities.

CONCLUSION

Governments can attract private investment in infrastructure in two ways. They can offer
financial support to investors-in the form of grants, cheap loans, or guarantees-in order to
compensate them for low tariffs, unstable macroeconomic conditions, poor performance by state-
owned enterprises, and other problems. Or they can address the policy problems that underlie
investors' concerns by raising prices to cost-covering levels, ensuring macroeconomic stability,
and establishing a sound regulatory framework.

Both methods can attract investors, but the provision of government support tends not to reduce
overall costs. Instead, it allocates costs to taxpayers, who have no choice but to accept them.
The costs of providing guarantees may be deferred, but they are real-as the examples of the
Mexican and Spanish toll roads show so vividly. In contrast, policy reforms such as price
increases and the establishment of credible regulatory frameworks improve project fundamentals,
making them attractive to investors without imposing extra costs on captive taxpayers.

20
REFERENCES

Chen, A.H., J.W. Kensinger, and J.D. Martin. 1989. "Project Financing as a Means of Preserving
Financial Flexibility." Working Paper. Austin, Texas: University of Texas.

Dailami, M. 1992. "Optimal Corporate Investment in Imperfect Capital Markets: The Case of
Korea." In S. Ghon Rhee and R.P. Change, eds. Pacific-Basin Capital Market Research.
Amsterdam: North-Holland.

Dailami, M. 1997. "Infrastructure Project Financiability: The Role of Government Guarantees."

Unpublished World Bank discussion paper.

Dailami, M., and D. Leipziger. 1997. "Infrastructure Project Finance and Capital Flows: A New
Perspective." Paper presented at the Development Economic Study Group Conference,
Birmingham, England, September 7-8, 1997.

Dasgupta, S., and K. Sengupta. 1993. "Sunk Investment, Bargaining, and Choice of Capital
Structure." International Economic Review. February: 203-220.

Dooley, M.P. 1997. "Governments' Debt and Asset Management and Financial Crisis: Sellers
Beware."

Edlin, A., and S. Reichelstein. 1996. "Holdups, Standard Breach Remedies, and Optimal
Investment." American Economic Review 3: 478-501.

Galal, A., L. Jones, P. Tandon, and I. Vogelsang. 1994. Welfare Consequences of Selling Public
Enterprises: An Empirical Analysis. Washington, D. C.: World Bank.

G6mez-Ibafiez, Jose A., and John R. Meyer. 1993. Going Private: The International Experience
with Transport Privatization. Washington, D.C.: Brookings Institution.

Haberer, L. 1996. Global Project Finance. New York: Standard & Poor's.

Huizinga, H. 1997. "Are There Synergies Between World Bank Partial Credit Guarantees and
Private Lending?" Policy Research Working Paper 1802. World Bank, Department
Research Group, Washington, D.C.

Ingram, Gregory, and Marianne Fay. 1994. "Valuing Infrastructure Stocks and Gains from
Improved Performance." Background paper prepared for the World Bank's World
Development Report 1994.

Inter-American Development Bank. 1995. Directory of Innovative Financing. Washington, D.C.:

Inter-American Development Bank.

21
IntpmrtionalFinance Corporation. 1996. Financing Private Infrastructure.Washington,D.C.:
World Bank and InternationalFinanceCorporation.

Kensiigcr, J.W., and J.D. Martin. 1988. "Project Finance: Raising Money the Old-Fashioned
Way."Journal of Applied Corporate Finance 3: 69-81.

K1ein,Michael. 1996. "Risk, Taxpayers,and Role of Govemmentin Project Finance." Policy

ResearchWorkingPaper 1688. WorldBank,Washington,D.C.

Kle6, M., and N, Roger. 1994. "Back to the Future: The Potential in Infrastructure
Privatization." Finance and the International Economy: 8.

Ncvitt, P.K., and F. Fabozzi. 1995. Project Financing. Sixth Edition. London: Euromoney
Publications.

Project Finance International. 1997. "PFI League Tables 1996-PF Business Nears US$50 bn."
Project Finance International, 113,29 January 1997.

SayeT,R ed. 1997. Projectand TradeFinance.

Vives, A. 1997InfrastructureFinanceDirectory.Washington,D.C.: Inter-AmericanDevelopment

Eank.

WorldBanlk.1994.WorldDevelopmentReport.Washington,D. C.: OxfordUniversityPress.

Wor1lBank. 1997a.GlobalDevelopmentFinance1997. Washington,D. C.: WorldBank.

'WorldBank. 1997b. World Development Indicators 1997. Washington, D.C.: World Bank.

22
Table Al Signed project finance deals, by country, 1996

Standard& Poor's Valueof Value of signed Value of

long-term,foreign Number signed projectfinance signed
currency of signed project deals, by project
sovereign project finance population financedeals
debtrating finance deals ($ million/per GDP as a percent
Country (March 11, 1997) deals ($ millions) capita) ($ millions) of GDP
United States AAA 103 48,669 185.0 6,952,020 0.70
Hong Kong A 36 19,376 3,229.3 143,669 13.49
Indonesia BBB 72 14,145 73.0 198,079 7.14
United AAA 41 13,227 227.0 1,105,822 1.20
Kingdom
Australia AA 44 12,731 705.3 348,782 3.65
Thailand A 31 9,432 158.8 167,056 5.65
China BBB 64 8,383 6.9 697,647 1.20
India BB+ 28 6,911 7.4 324,082 2.13
Gennany AAA 9 6,236 76.4 2,415,764 0.26
Brazil BB- 23 5,796 37.2 688,085 0.84
Qatar BBB 3 4,710 8,563.6 ----
Canada AA+ 23 4,469 150.9 568,928 0.79
Italy AA 6 4,443 77.7 1,086,932 0.41
Turkey B 14 3,890 63.1 164,789 2.36
Saudi Arabia NR 6 3,833 214.4 125,501 3.05
Malaysia A+ 13 3,575 177.5 85,311 4.19
Argentina BB 19 3,447 99.1 281,060 1.23
Chile A- 15 3,321 233.9 67,297 4.93
Greece BBB- 2 2,951 282.1 90,550 3.26
Pakistan B+ 13 2,738 21.1 60,649 4.51
Note: Population and GDP data are for 1995.
Source. Project Trade and Finance Database; World Bank 1997b; Standard & Poor's; World Bank staff
estimates.

23
Table A2 Top ten emerging markets for project finance deals, 1996

Country Number of projects Total project value

($ millions)
Indonesia 72 14,145
Thailand 31 9,432
China 64 8,383
India 28 6,911
Brazil 23 5,796
Turkey 14 3,890
Malaysia 13 3,575
Argentina 19 3,447
Chile 15 3,231
Pakistan 13 2,738
Source: Project & Trade Finance March 1997.

Table A3 Top ten emerging markets, 1995-1996

1995 1996
Country $ millions Country $ millions
Indonesia 3,384 Indonesia 4,306
Qatar 1,911 Colombia 1,557
Mexico 1,066 Philippines 1,097
Pakistan 1,062 Argentina 735
Turkey 929 Mexico 272
Colombia 660 Thailand 272
China 621 India 267
India 523 Chile 167
Chile 500 Poland 128
Hungary 397 Pakistan 97
Source: Project Finance International 1995; Project Finance International 29 January 1997.

24
Table A4 Privatization transactions in selected emerging markets, 1991-1995

Infrastructure
Number of privatization as a
infrastructure Total number of percent of total
Country privatizations privatizations privatizations
Argentina 11,424 14,378 79.5
Mexico 4,958 21,278 23.3
Malaysia 4,248 8,735 48.6
Hungary 4,064 7,013 57.9
Indonesia 3,428 4,014 85.4
Peru 2,520 4,457 56.5
Venezuela 1,983 2,501 79.3
China 1,370 7,033 19.5
Czech Republic 1,361 2,297 59.3
Pakistan 1,011 1,565 64.6
India 973 4,447 21.9
Russia 787 1,255 62.7
Bolivia 770 811 94.9
Philippines 629 3,338 18.8
Brazil 491 9,606 5.1
Chile 403 619 65.2
Turkey 347 2,401 14.4
Thailand t80 953 18.9
Poland 172 2,932 5.9
Latvia 160 160 100.0
Slovak Rep. 28 1,482 1.9
Estonia 6 245 2.6
Nigeria 3 176 1.6
Vietnam 1 3 22.2
Colombia --- 905 0.0
Jordan 15 0.0
Kazakhstan -- 315 0.0
Oman --- 62 0.0
Slovenia --- 521 0.0
South Africa --- 5 0.0
Uruguay --- 2 0.0
Zimbabwe --- 307 0.0
Total 39,583 114,964 34.4

Source: World Bank Privatization Database; International Economics Department;

World Bank staff estimates.

25
Table A5 Sovereign credit ratings, country risk assessment, and sovereign defaults
in selected emerging markets

Standard& Moody's long-

Poor's long-term term foreign Institutional
foreign currency currency Euromoney Investor Years in default
sovereign sovereign country country since 1975(foreign
debt rating debt rating ratings ratings' currency external
Country (April 9, 1997) (April 9, 1997) (March 1997) (March 1997) bank Debt)
Malaysia A+ Al 83.32 67.5 None
Thailand A A2 77.09 61.1 None
Czech Republic A Baal 74.54 62.8 None
Chile A- Baal 79.94 62.0 1983-1990
Slovenia A A3 73.97 52.1 1992-1995
China BBB A3 70.50 58.0 None
Indonesia BBB Baa3 70.95 51.6 None
Latvia BBB NR 55.04 29.1 None
Hungary BBB- Baa3 70.06 47.6 None
Oman BBB- Baa2 69.92 52.8 None
Colombia BBB- Baa3 63.68 47.7 None
Poland BBB- Baa3 56.58 47.9 1981-1994
Slovak Rep. BBB- Baa3 63.46 43.9 None
India BB+ Baa3 64.61 46.3 None
South Africa BB+ Baa3 69.88 46.0 1985-1987, 1989, 1993
Philippines BB+ Ba2 63.14 42.3 1983-1992
Uruguay BB+ Bal 63.42 41.7 1983, 1987, 1990-1991
Peru BB+ B2 48.19 32.0 1976, 1978, 1980,
1984-1995
Mexico BB Ba2 64.14 42.6 1982-1986, 1988-1990
Argentina BB Bi 59.17 39.9 1982-1993
Jordan BB- Ba3 53.20 33.8 1989-1993
Russia BB- Ba2 43.97 23.5 1991-1995
Brazil BB- BI 59.11 38.8 1983-1994
Kazakhstan BB- Ba3 40.25 20.9 None
Pakistan B+ B2 48.94 27.7 None
Turkey B Bl 53.39 40.8 1978-1981
Venezuela B Ba2 49.08 33.1 1983-1988, 1990
Vietnam NR NR 52.41 32.5 1985-1995
Zimbabwe NR NR 42.00 32.3 None
Estonia NR NR 53.21 33.6 None
Nigeria NR NR 26.78 14.8 1982-1992
Bolivia NR NR 45.93 24.9 1980-1993
Note: a The scale for Euromoney and Institutional Investor country credit ratings range from 0-100. The
highest possible score is 100 and the lowest possible score is 0.
Source: Standard & Poor's; Moody's; Euromoney; and Institutional Investor.

26
 Table A6 Capital market innovations, 1991-1996

Project Location/
Year Capital Market Innovation Project Country of Origin
1991 Developer took long-term project risk. Midlands Power Project United States

1992 Project received investment grade rating and obtained Sithe Energy 144A Bond Offering United States
capital market financing in precompletion stage.

Project risk undertaken by developer in transport sector Mexico City-Toluca Toll road Mexico
project in an emerging market. Longer maturities.
Securitization of toll road revenues through offshore
debt fund for a 144a issue.

1993 Developer took long-term market risk. Deer Park Refinery United States

Pooling debt of multiple projects. Project financing to Refinancing of Project United States
receive an investment grade Partnerships Owned by Coso
Energy

First IPP in Latin America Mamonal Power Project Colombia

First major private infrastructure project in Eastern MI/Ml5 Motorway Hungary

Europe. Project also did not have government
guarantees.

Project risk undertaken by developer in power sector in Subic Bay Power Project Subic Bay, Philippines
emerging market

1994 Construction risk was undertaken by project developer. Indiantown Cogeneration United States

Debt of multiple projects was pooled to provide Energy Investors Fund Pooled United States
liquidity for investors in an otherwise illiquid long-term Portfolio Refinancing
fund.

Limited recourse refinancing of an IPP in the public Kilroot Electric Bond Issue Northern Ireland, United
bond markets in Europe. Kingdom

Take-or-pay contract with state-owned utility allowed YTL Power Generation Local Malaysia
for much longer maturities (10-years versus 50 years). Currency Bond Issue

First investment-grade project finance bond issue from Centragas Bond Issue Colombia
an emerging market. Construction and operation risk in
emerging market.

First financing in the U.S. for a Chinese power project. LIPTEC 144a Bond Offering China
Blind pool / power projects.

Rated Asian project financing of raising funds in the Regco Project Financing Thailand
United States.

Debt fund created to secure private loan. Eligible for Rockfort Power Project Jamaica
CARIFA bonds. Used multilateral bank guarantees to
fund IPP.

Market risk for power project in emerging market. Alicura Hydro Project Argentina

Discrete pool in emerging market. Tribasa Toll roads Mexico

Limited recourse financing for water and environmental Chihuahua Norte Municipal Chihuahua, Mexico
project. Indexed project revenues to inflation. Wastewater Treatment Plant

27
 Project Location/
Year Capital Market Innovation P,cject Country of Origin
1995 Privately financed undersea telecommunications cable. Fiberoptic Link Around the Globe 23 political jurisdictions
18-country political risk package. (FLAG) between UK and Japan

Offering of limited recourse notes in high-yield notes Califomia Energy Co./Salton Sea United States
market. Funding Corp. Debt Refinancing

Toll road financing syndicated in the equity and bond M2 Toll Toad New South Wales,
markets. Australia

Power transmission and cross-border project with Lineas de Transmisi6n del Litoral Argentina, Paraguay
multilateral bank guarantees. S.A.

Emerging market debt issue exceeded sovereign debt YPF Structured Export Notes Argentina
rating ceiling. Notes secured with a portion of future Private Placement
receivables through long-term oil purchase agreement.

Debt fund established. Used multilateral bank Hub River Power Project Pakistan
guarantees to fond IPP.

1996 Capital market refinancing in an emerging market. Pehuenche Bond Offering Chile

Precompletion financing obtained by emerging market Ibener Power Project Chile

without political risk insurance, multilateral bank
support or PPA.

Latin American company to enter US 100-yr. bond Endesa 3-Tranche Bond Offering. Chile
market.

Long-tenn refinancing of project finance with Paiton Energy Co. Bond Offering Indonesia
investment grade.

Latin American r.municipalitysyndicated loan. Bogotd Syndicated Loan Colombia

Toll road financing syndication in the equity bond Guangdong Provincial Guangdong Province,
market by a local government entity within an emerging Expressway Shareholding China
market.

Municipal government financing of greenfield toll road. Linha Amerela Rio de Janeiro, Brazil
Source: Inter-American Development Bank 1995; Vives 1997.

The authors would like to thank Albert Amos, Anita Hellstern,and Matthew Harvey for valuableresearch
assistance.

The key sourcesfor the infonnationpresented here are Project Finance International(1997), Sayer (1997),
Vives (1997),and WorldBank(1997a).

2 Somecountriesmay begin with publicownership,but the cyclicalforcesare the same.

3 In fact, they havebeen doingso for some time. Land grants and credit guaranteesfor internationalbond issues
were extended to railroads in India and South Africa in the nineteenth century, for example.

4 Such guarantees are primarily meant to support providers of long-term debt. Project fmancings are typically
funded with a very high share of debt, usually ranging from 60 to 80 percent of total project cost. Reliance on
steady uninterrupted adherence to scheduled debt repayment is key to the remuneration of long-term creditors, who

28
 do not benefit from the high returns that equity holders may expect. Guarantees of continuous creditworthiness are
thus of great value to creditors.

In project financing, debt often accounts for 60-80 percent of total project cost. In contrast, corporate finance,
equity, particularly in the form of internal cash generation, tends to dominate funding. For a discussion of
corporate finance in developing countries see Dailami (1992). Project financing has also been revived in
industrial countries as a method of financing large-scale investment projects (see, for instance, Kensinger and
Martin [1988]; Chen, Kensinger, and Martin [1989]; and Nevitt and Fabozzi [1995]).

6 In some cases risks are so high that no investors will invest, and funding is effectively rationed.
7 There is no fundamental difference between a concession in which the government remains the notional owner,
as in the French water system, and a full asset sale, in which the government retains special supervision rights
defined in a license, as in the water privatizations in England and Wales.

8 Under corporate finance investors look towards the cash flow of the whole company that sponsors the project.
Corporate finance allows project sponsors to use other existing revenue-eaming activities to "collateralize"
investment in a project. Various hybrid schemes exist such as project finance of a toll road expansion that benefits
at the same time from toll collection on already completed stretches of highway.

29
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